Sterling slides after EU's Barnier warns on Brexit transition

LONDON (Reuters) - Sterling erased recent gains and slid against the dollar and the euro on Friday after the European Union’s Brexit negotiator warned Britain that a post-Brexit transition deal was “not a given”.

A British Pound Sterling note is seen in this June 22, 2017 illustration photo. REUTERS/Thomas White/Illustration

The pound enjoyed a bounce on Thursday when the Bank of England said interest rates probably needed to rise sooner and by more than it previously thought, as global growth helped the UK economy. Markets moved to price a 70 percent chance of a rate hike in May, up from 50 percent.

But the British currency quickly reversed those gains on Friday after the EU’s Michel Barnier said London had “substantial” objections to the EU’s transition offer and that parts of it were not up for negotiation.

The pound dropped 0.9 percent against the dollar to trade at a session low of $1.3786, its weakest since Jan. 17, before recovering slightly. Against the euro sterling fell as much as 0.8 percent to trade at 88.79 pence.

“[Barnier’s comments] have raised the risk that a transition deal may not be as easy to achieve as the market had expected,” said Lee Hardman, analyst at MUFG in London.

Sterling has rallied this year as investors bet Britain can secure itself a transition deal with the EU and then leave the bloc next year on favourable terms.

The Bank of England gave a rosier view of the British economy on Thursday, but its hawkish comments on interest rates hinged on smooth negotiations with the EU in the coming months.

Analysts said sterling’s short-term performance would depend on the haggling between Brussels and London, with a substantial move higher or lower dependent on whether a transition deal is secured.

Neil Jones, head of hedge fund FX sales at Mizuho Bank, said the pound “was pushing lower as the pendulum shifts from a soft to a hard Brexit.”

BREXIT ON THE RADAR

Big investors have bet on a rising pound in recent months, taking the view that Britain will retain as close as possible ties to the EU after departing - a so-called “soft Brexit”.

Not everyone is convinced. A Reuters poll of strategists found on Thursday that this year’s sterling surge is over, and concerns over Brexit will start weighing the currency down again.

“Over half of the gains that the pound made since the start of the year against the dollar have been wiped out,” said Hamish Muress, currency analyst at OFX.

“The losses against the euro are even more pronounced. With Brexit once again moving back onto the markets’ radar, risk of a sterling downturn has returned and even the Bank of England’s aggressive policy outlook hasn’t provided much support to the pound.”

BoE Deputy Governor Ben Broadbent said on Friday he did not think a couple of interest rate hikes within a year should come as a great shock, though he also added that the central bank had not fixed any path for tightening policy.

That came a day after the BoE said it was likely to tighten policy sooner and by more than policymakers had reckoned only three months ago.

Data on Friday showing British industrial output sank by more than expected in December had little impact on the pound.